Keeping the Rally's Rewards

What has to change now for you to protect profits? First, get back into a swing-trading mentality. Stop pressing your luck during bounces and upticks. Instead, use short-term resistance to feed positions into the hands of those who are still chasing the market. Then reverse gears and play the short side aggressively.

Short-selling has been unprofitable for months, but that's about to change. The trading flow is showing more fear now than at any time since early April. This is an important signal when it corresponds with markets failing to hit new highs. It means there are a lot of itchy fingers out there ready to hit their sell buttons.

The public is holding too many long positions right now. This imbalance could become rocket fuel for short-sellers as the markets pull back. The downward pressure would undermine the short squeeze and let bounces fail at common resistance levels. The result: low-risk short-sale entries with decent profit potential.

Swinging Through the Summer

The market will become more technical in nature over the summer months. The emotional fires will subside and let classic swing strategies work their magic. Profits during this quieter period will require a working knowledge of pivot points on the indices and futures.

It should be a good time for scalping and one- to three-day swing positions. But daytraders may have a tough time, because daily ranges should contract until the start of tax selling season. Now is not the time for new investments or long-term positions in either direction. Shorten your holding period and be willing to take smaller profits on each winning position.

Smaller profits require trading strategies that yield smaller losses as well. This could be a problem if you don't adapt quickly to the changing market. Many traders now let positions move against them because they're conditioned to believe "they always come back." Remember what happened after the December highs? The markets dropped day after day, washing out everyone who bought the dip.

But I don't expect a deep correction this summer, because the rally mounted several key resistance levels. This suggests the dips will be bought until the indices complete a broader top or set the stage for another rally. So, is it a good idea to buy the summer pullbacks? I suspect the market will find other ways to shake out dip-trippers.

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The odds favor many "gap and trap" scenarios in the coming weeks. This nasty reversal takes place when an opening gap in the same direction as the prior day's move gets filled immediately and traps those foolish enough to believe their eyes. These sucker gaps could provide an efficient way to shake out the dip-buyers. In fact, shakeouts of all kinds should become more common as we press through earnings season.

It's likely the long summer will make us question our trading strategies, skills and risk tolerance. I guess that's inevitable after we've forgotten three years of important lessons in less than three months.

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Alan Farley is a professional trader and author of The Master Swing Trader. Farley also runs a Web site called HardRightEdge.com, an online resource for trading education, technical analysis and short-term investment strategies. At the time of publication, Farley had no positions in trading vehicles mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Farley appreciates your feedback and invites you to send it to [e-mail]. Also, click here to sign up for Farley's premium subscription product The Daily Swing Trade brought to you exclusively by TheStreet.com.

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